Congress may hand oversight of almost 12,000 investment advisors to Wall Street's self-funded regulator as a cost-saving measure. The price could be paid by investors.
The Financial Industry Regulatory Authority, deputized by the government to oversee brokers, is lobbying to replace the Securities and Exchange Commission as a regulator of registered investment advisors who manage about $40 trillion. Congress is considering the move as a cheaper alternative to increasing resources for the SEC, since Finra's $877 million budget is paid by the brokers it regulates.
"It's a very bad idea to expand the notion of self-regulation," said Denise Voigt Crawford, former commissioner of the Texas State Securities Board. "They're supposed to oversee the activity of the industry, but they are industry."
Finra, established in 2007 by the merger of the National Association of Securities Dealers and most of the New York Stock Exchange's regulatory unit, has done a poor job of protecting investors, said Crawford, who retired in February after 17 years as a securities commissioner. Fines imposed are usually a fraction of the damages suffered, and Finra fails to share information regularly with state regulators, she said.
The regulator fined members almost $43 million last year, while the SEC, working with a similar budget, issued more than $1 billion of penalties.
The Finra arbitration process is flawed, said Lynn E. Turner, who was the chief SEC accountant from 1998 to 2001. Investors who won Finra arbitration awards last year got back less than half of what they sought, data from Securities Arbitration Commentator Inc. show.
Compensation exceeding $11 million in 2009 for the top 10 Finra executives makes them reluctant to "make waves" in the industry that provides the funding, Turner said. Finra's chairman and chief executive officer, Richard Ketchum, said that level of pay keeps them from losing their best staff.
In a January report required by the Dodd-Frank financial overhaul bill, the SEC gave Congress the option of naming an outside regulator to strengthen oversight of investment advisors as the agency faces strained resources. Only about 9% of advisors registered with the SEC were examined in 2010 because of decreased numbers of agency examiners, the report said.
Advisors are currently required to register with the SEC if they are paid to give retail investment advice about securities and have more than $25 million of assets under management. The limit is set to become $100 million next year.
Investment advisors must uphold a fiduciary duty to put their clients' best interests first, generally charge fees and may provide services ranging from saving for retirement to tax planning. Brokers usually are held to a suitability standard that only requires that advice meets their clients' needs when a product is sold. They generally charge commissions. The number of registered investment advisors increased by almost 40%, to 11,888 advisors, as of Sept. 30 since October 2004, the SEC report said.
"The likelihood of an SEC government solution working and working consistently in a difficult budget environment I think is low," Ketchum said in an interview last month. The current environment "is simply not an appropriate level of investor protection."
Finra is a "natural organization to be part of the solution" because of its infrastructure and technological capabilities and the fact that most advisors are affiliated with broker-dealers, Ketchum said.
The regulator would need as many as 200 more people to do the job and would create a new board to represent members of the advisor community, he said. Michael Oxley, the former congressman who co-sponsored the Sarbanes-Oxley Act of 2002, registered earlier this year as a lobbyist for Finra to advance its case. The regulator spent $300,000 in the first quarter lobbying Congress on issues including advisor oversight.
Finra has stepped up its enforcement efforts this year. From January through May, fines levied by Finra increased by 118%, to $28.1 million, compared with a year earlier. During the first five months of 2009, in the wake of the financial crisis, fines were $30.5 million. The number of disciplinary actions taken this year through May was 463, the most in at least five years.
Morgan Keegan, a division of Regions Financial Corp. in Birmingham, Ala., agreed to pay about $200 million to settle investigations into subprime mortgage-backed securities by the SEC, Finra and state regulators, the company said last week. Morgan Keegan's actions may have resulted in $1.5 billion of losses, Joseph Borg, director of the Alabama Securities Commission, said during a call with reporters. The investigation was a "collaborative effort," said Nancy Condon, a Finra spokeswoman.
The regulator has been "digging deeper" into "areas of concern" such as structured products and private placements, Ketchum said last month at Finra's annual conference in Washington. Finra has fined brokerage firms for misleading investors about the safety of "principal-protected" notes and ignoring signs of fraud when selling high-yield securities.
Customers filed 3,208 complaints last year either online or through the mail with Finra. Every complaint was reviewed, responded to and investigated when warranted, Condon said.
The total amount of fines brought by Finra was about $42.5 million in 2010, compared with about $1.03 billion by the SEC last fiscal year. The SEC figure includes a $535 million penalty for Goldman Sachs Group Inc. to settle claims that it misled investors in collateralized debt obligations linked to subprime mortgages. The SEC doesn't break out separate numbers for fines of brokers, said John Nester, a spokesman for the SEC. Finra may refer cases to the SEC, which has civil law enforcement powers.
Finra also ordered $6 million in restitution to harmed investors last year. That compares with about $1.82 billion in illegal profits that the SEC has ordered repaid and returned to investors when possible. This year through May, Finra restitution was $9.8 million. The self-regulator has almost as much funding as the SEC, which had a budget of $960 million in 2009.
"When you look at the types of misconduct compared to the fines, you have to wonder if it will really deter the misconduct they're tasked with cracking down on," said Michael Smallberg, an investigator at the nonprofit Project on Government Oversight in Washington. "Would Finra ever take serious action against who it's relying on for its funding?"
Clients must generally resolve disputes with brokers through arbitration rather than lawsuits because of clauses in their contracts. In 2010, the median amount won by investors through Finra arbitration was $129,800, or 42% of the median amount of $310,000 in compensatory damages sought by investors who won, according to data compiled by Securities Arbitration Commentator Inc., a legal publishing and research firm in Maplewood, N.J.
The firm excluded cases where the customer asked for less than $25,000 as well as cases that didn't specify the amount of compensatory damages requested. Of the 882 arbitration cases that were decided in 2010, 47% resulted in customers being awarded damages, based on Finra data.
Arbitration is "far from perfect," but it's cheaper and faster than the public courts, said Finra's Ketchum. Starting in February, investors were given the option to pick an all-public panel of three arbitrators to decide the case instead of a panel composed of two public arbitrators and one from the industry. Since February, 77% of claims filed have selected the all-public panel, Condon said. It can take up to two years from when investors file their arbitration claims until the case is closed, said Jeffrey Erez, a securities attorney in Fort Lauderdale, Florida.
-It's rare that arbitration claims lead to disciplinary actions such as fines or suspensions, according to Stuart Meissner, a securities attorney in New York and former state assistant attorney general.
"There's a breakdown between arbitration claims and enforcement actions," Meissner said. "It's only the most egregious cases."
Fewer than 1% of arbitration cases on average have resulted in disciplinary actions against brokers or brokerage firms, based on interviews with five securities attorneys around the country including Steve Miller, an attorney in Denver who also serves as a Finra arbitrator.
Every arbitration claim is reviewed and may be a source of future cases, said Stephen Luparello, Finra's vice chairman. A single enforcement action may result from multiple arbitration claims.
Self-regulatory organizations work if there's aggressive SEC oversight, and the SEC has an "effective program" in place for overseeing Finra, Ketchum said. But the Boston Consulting Group found in a March report ordered by the Dodd-Frank Act that self-regulatory organizations, including Finra, don't have to regularly disclose information to the SEC regarding their regulatory operations. Nor does the SEC have a consistent set of metrics or standards to assess Finra, the report said. Nester, the SEC spokesman, did not comment on the agency's oversight of Finra or Finra's regulation of brokers.
As more investors turn to investment advisors for financial help, who regulates them will matter even more, said Seth Lipner, a Garden City, N.Y., attorney. "If we want to seriously regulate investment advisors, we would not give it to Finra because it hasn't proved it's competent to protect the public interest."
